Although there’s a substantial gas storage surplus (458 Bcf versus 10-year norms) and the North American natural gas production decline of the last few years has ended, Henry Hub gas prices are unlikely to fall very far this year and should average about $6.50, analyst Stephen Smith said in his Monthly Energy Outlook for April.

However, Smith did predict some near-term price weakness and Wednesday’s action in the Nymex natural gas futures pit appeared to support those predictions. May gas futures prices plummeted well below $7/MMBtu on expiration day.

“Assuming normal summer weather and upper $40s [West Texas Intermediate crude oil prices], we expect Henry Hub prices to trend from the current $7/MMBtu toward $6/MMBtu as the summer progresses,” said Smith.

But he said the gas price environment of April 2005 is basically unchanged from the one experienced over the last 15 months. “Oil, the key competitive fuel for North American natural gas, is understandably being priced to reflect a tight and nervous global equilibrium [that] has little spare OPEC productive capacity. This suggests a continued pricing environment like the one we have had — WTI prices in the mid to upper $40s with occasional runs into the $50s (as we saw last October and again in March).”

A large part of the reason that gas prices remained greater than $7 in the face of the storage surplus has to do with the price strength of crude oil and residual fuel, Smith said. But in current tight supply/demand environment there’s a lot of “market nervousness” about the adequacy of gas supply. “As a result, the market has shifted its preference for seasonal gas storage norms upward by about 200-250 Bcf.” The industry simply needs more gas in the ground today compared to what was needed in the past.

That still leaves a storage surplus of 210-260 Bcf, according to Smith’s calculations. “While this is not a surplus which implies a major and immediate price correction, it does imply some downside price vulnerability (if the summer should be unusually mild or oil prices decline).”

The North American gas supply situation also has improved. While the decline in Gulf of Mexico production continues, albeit at a slower pace, declines are being offset by production growth in the Rockies and in other strong plays, such as the Barnett Shale in Texas and coalbed methane.

“Canadian gas production is now increasing again at a 2-3% rate and North American production for the next year or two should be expected to remain basically flat,” said Smith. “The first significant expansions of LNG import capacity will not occur until 2006.

“In this environment, a trading range of $5-7 is likely to persist… Assuming summer [cooling degree days] equal to the 1995-2004 norm, and an average $48 WTI price for the third quarter, we are estimating an average 3Q05 Henry Hub gas price of $6.25, followed by a firming to $6.60/MMBtu in 4Q05 in anticipation of winter.”

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